UK longevity risk transfer market implications for Asia

Transcription

1 UK longevity risk transfer market implications for Asia David O Brien FSA MAAA FIA SCOR Global Life 1

2 Longevity 1 Global trends in longevity 2 UK Market developments 3 Applications for Asia Pacific markets

3 Globally, populations are becoming older. Source : Global Population Ageing World Economic Forum 2012 report

4 Populations are getting older Source : International Actuarial Association Oct 2013 (presented in EAAC)

5 People are living longer Female life expectancy at age 65, Direction of travel identical but rate of change varies by country and time period: 21 Japan: 20 (1990) to 24 (2009) Netherlands: 19 (1990) to 20.8 (2009) Netherlands England and Wales France Germany (West) Japan USA Austria Source : Human Mortality Database. University of California, Berkeley (USA), and Max Planck Institute for Demographic Research (Germany). Available at (downloaded in May 2012)

6 ..with a very mixed picture of income security for the elderly, and historically, limited private sector involvement outside Western nations. Source : Global Age Watch Rankings 2014

7 Private sector role in taking longevity risk varies widely Macro Longevity Pension / Annuity Assets Potential Longevity Market Size Regulatory & Accounting Conditions Pension Scheme Insured Annuity Australia Brazil Canada France Germany Ireland Israel Japan Netherlands Spain Switzerland UK US

8 Defined Benefit vs. Defined Contribution Globally the aggregate value of private DB pension liabilities totals US$ 23 trillion The uncertainty of these liabilities has been crystallized in a low interest rate environment, creating motivation for risk transfer The global volume of longevity risk is larger than the ability of the insurance sector to absorb it Defined Benefit Plan Defined Contribution Plan Longevity risk Fund Asset risk Employee Annuity payout Lump Sum Longevity risk NO risk! Place the investment risks associated with market fluctuations upon the employer Corporations typically save significant amount of money with DC plan as the benefits afforded by DC plans are lower

9 Defined Benefits vs. Defined Contributions Source : Towers Watson: Global Pensions Asset Study 2013 and OECD, Pension Markets in Focus, Sep 2012, Issue 9 *Pension plans in Germany can actually be traditional DB plans or hybrid DB plans, but the split between the two categories is not available

10 Longevity 1 Global trends in Longevity 2 UK Market Developments 3 Applications for Asia Pacific markets

11 UK Longevity Market Demand from DB Pension Schemes UK defined benefit pension assets over 1,000bn; liabilities closer to 1,500bn So far less than 5% of longevity risk passed to insurance/capital markets More than 70% closed to new members and increasingly closing to future accrual too Closure can increase funding cost Recognition of deficit/surplus in accounts causing undesirable balance sheet and income statement volatility Investment returns lower than expected in last 10+ years so many schemes have deficits Increased scrutiny of pension liabilities by analysts, rating agencies, lenders and shareholders Potential stumbling block for M&A transactions (e.g. BA/Iberia) Strengthened funding assumptions have made transactions appear more affordable for schemes Schemes expected to use assumptions appropriate to their membership profile; assumptions not prescribed by the Pensions Regulator Peer pressure with respect to improvement assumptions Increasing awareness by sponsors and trustees of longevity risk Previous focus was on inflation and interest rate risks Lower interest rate environment heightened relative cost of longevity Many larger schemes already hedge asset risk, longevity risk is remaining unhedged risk

12 UK Longevity Market Pension Scheme De risking: Strong transaction flow in 2014 Sources:

13 UK Longevity Market Demand from Individual Annuities In excess of 600bn assets covering employer sponsored DC and personal pensions 140bn backing post retirement insurance annuity reserves Rapid growth due to closure of DB schemes and demographic changes UK market accounts for an estimated 40% of total global annuity market Increasing awareness that state retirement benefits are insufficient and likely to reduce further in future Insurers have a limit on exposure they wish to retain so look to reinsurance and capital markets For some smaller insurers, the long tail of annuity business shows that it can dominate them in a few years Solvency 2 stress for longevity focussing further attention Recent changes to requirement to annuitise pension savings pot are likely to shrink this market for new business

14 Reinsurance Structure for UK Market Wholesaler Packager Retailer Customer Investment Bank Capital Market Investor Defined Benefit Pension Scheme Bulk Annuity Insurer Insurer (standard health annuity) Personal Pension Insurer (underwritten annuity) Reinsurer 14

15 Reinsurance Structure for UK Market Typical DB Pension Scheme Solutions Swap (index or bespoke; natural expiry or limited duration) Pension Scheme Regular Claims (Actual annuities) Regular Premiums (Expected annuities + margin) (Re)insurer Only longevity risk transferred Buyout/Buy-in Pension Scheme Regular Claims (Actual annuities) Single Premium paid on day 1 (Re)insurer Longevity and asset risk transferred Buyout: removes all risk including operational risk from scheme and individual pensioner has contract with insurer Buy-in: insurance asset bought by scheme, scheme retains operational and counterparty credit risk. Scheme retains obligation to pay pensioners

16 SCOR Longevity Deals in the Netherlands A solvency II driven solution An innovative out-of-the money index option that protects the ceding company from (i) improvement in Dutch mortality trend primarily and (ii) adverse deviation in US mortality experience to a lower extent, above an agreed on threshold and up to a defined limit The deal was calibrated according to the ceding company s internal model so that full Solvency II benefit is provided Transaction s benefits Ceding Company Benefits The transaction mainly aims at hedging longevity trend risk at level of risk consistent with Solvency II framework Transfers the longevity and mortality risks at an efficient cost of capital Gets capital relief Keeps all upside : favorable mortality and longevity deviations benefit to the ceding company only Low counterparty risk as this is mitigated through collateral arrangements Costs This is not a perfect hedge - Some basis risk is retained by the ceding company

17 Longevity 1 Overview 2 UK Market Developments 3 Applications for Asia Pacific markets - Management of existing longevity risks - Public policy as an engine for change - Innovation in product design to demonstrate value for money

18 Existing longevity exposures in Asia Pacific some pre conditions for effective management Accounting Standards National accounting standards for recognition of corporate pension arrangements are progressively adopting IAS approach to recognise funded and unfunded obligations as on-balance sheet obligations, with a requirement to periodically recognise changes in this value. This is a prerequisite for liabilities to be valued close to fair value. Fair Value of Liabilities Assessment of pension obligations is often based on population or industry tables of mortality that are not calibrated to the specifics of the risk group. Provision for explicit mortality improvement makes transparent the level of provision arising for lengthening lifespan. Relationships Drivers Mechanism for risk transfer Precedent transactions are important but challenging to execute Accounting, tax and regulatory framework need to be aligned Framework for long term handling of collateral to manage counterparty risk is challenging. High quality data to analyse trends and to reliably execute on a swap agreement is work in progress. Incentives for de-risking Investor, rating agency and regulator awareness of longevity risk exposure often accelerates risk management action Legislative and corporate governance framework needed to support de-risking Market scale The UK and US corporate sector have significant longevity exposures. Large scale prompts investment by reinsurers and banks to provide competitive solutions Korea and China arguably have exposures supportive of formation of a tradable market

19 Public policy lessons high stakes changes under way Contrasts with UK move Sources:

20 Innovations in longevity product design must show value for money Declining global interest rates and increasing lifespans make conventional lifetime annuities seem very expensive in nominal terms

21 Innovation impaired annuity Sources

22 Innovations in longevity product design show value for money Impaired annuities are winning UK market share

23 Innovation continued US carriers offer longevity insurance protection with long deferral of payments Source: Note indicative rates only

24 Innovation continued Sales momentum is positive Source:

25 Potential to offer longevity protection in Asia - Some hurdles to overcome Value for money concern Longevity protection is an abstract concern with very long term payoff, and some (usually significant) sacrifice of liquidity Cash values can be added as riders but are very expensive given low yields Some bundling of longevity protection with savings vehicles is needed Awareness Wealth management advice is focused on accumulation phase and basic protection needs Financial planning gap arises for mass market longevity is no exception Relationships Drivers Data and Knowledge Wide variation in longevity outcome according to socio economic position, income, and access to healthcare. No meaningful baseline of insured experience to start from Limited track record in product management of longevity products (other than as rider benefits) Regulatory Permitting basic longevity products that have no cash value payment obligation would open the market to best practice products that can then be bundled flexibly with other retirement options such as phased income drawdown. Incentives Mandated annuitisation of some level of pension savings is a game changer to create awareness and a marketplace Immediate annuity and deferred annuity products create a strong demand for long term high quality bond issuance